Divining The Social Security Of The Future

May 6, 2012 | By Nathan Lewis

It seems to me that we are in an era where our postwar institutions, having become outdated and often corrupt, are gradually collapsing. This is true across our society, whether public and university education, social security, unions, pensions, the health care system, the financial system, big government in general, or even the suburban pattern itself. Things that used to work no longer work.

In this regard, I am a fan of the writing of William Strauss and Neil Howe, who predicted that all of this would happen in the middle of the happy 1990s, when it seemed to most people that everything would be fine and the DJIA would rise placidly to 36,000. Their book The Fourth Turning(1997) is a good place to start.

Politically, at present, it seems to me that not much can be done. The attempt to maintain the present institutions will overwhelm all efforts of reform. However, it is a good time now to start to think about what our new institutions should look like.

Unlike many libertarian types, I think the notion of Social Security is, broadly speaking, a good thing. The countries that have tried to do without, such as libertarian Hong Kong, have found that the problems of old-age poverty became too serious to ignore. This is especially true since, due to demographic changes, more and more of the populations in most developed countries are over 65. Hong Kong instituted its “Mandatory Provident Fund” system in 2000, which puts a mandatory 5% contribution at both the employee and employer level into an account that holds private-sector assets.

Similar plans are in use in India, Singapore, Malaysia, South Africa, New Zealand, Chile and other places around the world. A 2005 study by the U.S. Social Security system itself found 31 countries, and I think they missed a few.

The Cato Institute, in February 2012, found that a simple 50% equity/50% bonds portfolio, begun in 1968 (not a very auspicious time as it was the beginning of a long bear market in both stocks and bonds), would have allowed monthly benefits of $2,067 today for the average family, compared to $1,358 from today’s Social Security system.

This is all well and good, but there is another factor which I think is more important – capital formation. Capital investment – the flip side of savings – is what drives wealth creation, increasing incomes and job creation in any economy. We are today saturated with the idea that “consumption” makes an economy go, and there is some truth to that, but mainstream economists will agree that capital investment is a more fundamental long-term driver of economic gains.

In practice, domestic savings and domestic investment don’t line up perfectly. There are countries, like the U.S., which use more capital than they create. This causes a current account deficit, or more specifically indebtedness to foreigners, which is a touchy subject for a lot of people.

However, even when capital flows across borders relatively easily, as is often the case today, there remains considerable “stickiness.” In other words, countries with a high degree of domestic savings, like China, typically also have a high degree of domestic investment. The kind of small, entrepreneurial ventures that often have the best return on capital are usually funded by people who are familiar with the local situation. Foreigners like to buy government bonds. And if savings were in excess of local investment – in other words, if the U.S. began to run a current account surplus – that might not be such a bad thing either.

We want to channel capital to real productive uses, not government squandering. On the other side of every private investment is a productive asset: your bond finances an office building, which generates the revenue to pay the bond. Or, your stock finances a corporation, which generates cashflow and profits. More private investments means more productive assets, which is another way of saying a larger, wealthier, job-creating economy.

The idea that capital creation and investment should be a primary goal of public policy was a central economic tenet for literally centuries. However, the notion seems lost today.

The United States today gives me the impression of an economy that is capital starved. Net private investment by businesses averaged 5.1% of GDP in the 1960s. In the last ten years, it averaged 1.92%. In that difference lies many reasons why job creation and wages have been stagnant. Social Security brought in and paid out about 4.8% of GDP last year – money which, if it were directed into private-sector investments, instead of the present pay-as-you-go system, would provide that much more capital for private-sector investment and job-creation.